Journal Article

A perspective on modern business cycle theory

Abstract: In this article I provide a perspective on the current state of modern business cycle theory. This theory has developed from an application of the Arrow-Debreu general equilibrium framework to the neoclassical growth model. On the positive side, this approach is able to accommodate various sources of heterogeneity in preferences and production within its complete markets framework. On the negative side, this approach has to rely on persistent exogenous shocks to account for business cycles since its internal propagation mechanism is weak. I discuss the implications of three important extensions of the basic framework. The first two extensions, noncompetitive pricing and frictional labor markets, do not overcome the basic weakness of limited propagation. The third extension, limited insurance and exogenous credit constraints, shows promise to account for the amplification and propagation of exogenous shocks.

Keywords: Labor market; Business cycles;

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Economic Quarterly

Publication Date: 2011

Volume: 97

Issue: 3Q

Pages: 195-208